Bank of England Ties Interest Rate to Employment

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The Bank of England said it did not plan to increase interest rates, currently at 0.5 percent, until the unemployment rate declined to at least 7 percent from the current level of 7.8 percent.CreditCreditToby Melville/Reuters

LONDON — In a significant shift in strategy intended to spur Britain’s economic recovery, the Bank of England said Wednesday that it would aim to keep interest rates at a record low until the nation’s unemployment rate declines to at least 7 percent.

By linking future rate decisions directly to the jobless rate, the Bank of England’s new governor, Mark J. Carney, broke with tradition and aligned the bank more closely with the Federal Reserve’s policy of providing more clarity about its intentions. Mario Draghi, the president of the European Central Bank, hs also recently moved to reassure markets by saying the institution would not raise its benchmark interest rates for some time.

Short of pumping more money into economies that are still struggling to recover, central bankers in Europe have been seeking new ways to encourage banks to lend and to increase confidence among companies and consumers. Mr. Carney, who took over at the Bank of England last month, said linking interest-rate policy to unemployment was intended to reduce uncertainty.

The British Chambers of Commerce said that companies would get a “much-needed confidence boost when looking to invest, as they know that any plans will not suddenly be derailed by a hike in interest rates.'’

But some experts were more skeptical.

“It’s all fine now, but the problem is it gives potentially rise to unforeseen uncertainty when circumstances change,” said Simon Hayes, an economist at Barclays.

Mr. Carney is borrowing a strategy from his own playbook. In 2009, in his previous role as governor of the Bank of Canada, he committed to keeping interest rates stable for an extended period to help the country weather the financial crisis. That decision greatly impressed Britain’s chancellor of the Exchequer, George Osborne, who hired Mr. Carney for the top job at the Bank of England, where the hope is that providing similar guidance to the markets will give the British economy a much-needed lift.

The step represents a major change for the Bank of England, which under Mr. Carney’s predecessor, Mervyn A. King, rarely shared any insights into the thinking of the central bank’s rate-setting committee ahead of its decisions. The Fed, in contrast, has been more open. Its chairman, Ben S. Bernanke, has signaled that the bank’s policy of buying $85 billion a month in government bonds and mortgage-backed securities to spur the economy would be wound down when unemployment fell to about 7 percent. On Friday, the Labor Department reported that unemployment in July fell to 7.4 percent, from 7.6 percent in June.

But unlike the Bank of England, the Fed’s mandate includes not only controlling inflation but also minimizing unemployment. Still, the Bank of England’s shift in strategy hardly surprised economists and investors, who have been waiting for Mr. Carney to put his stamp of authority on the British central bank.

After an initial drop against the dollar after Mr. Carney’s announcement, the pound recovered and continued to strengthen Wednesday, rising against the euro as well. The FTSE 100 share index fell slightly, mostly because of the Bank of England’s forecast for a slow economic recovery.

Under its new strategy, the Bank of England said it did not intend to increase interest rates, currently at 0.5 percent, until the unemployment rate declined to at least 7 percent, from the current level of 7.8 percent. The central bank also forecast that unemployment might not reach that level until at least the third quarter of 2016, suggesting that rates could remain unchanged for another three years.

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The Bank of England governor, Mark J. Carney, on a TV at IG Index in London, said the policy was intended to limit uncertainty.CreditLuke MacGregor/Reuters

Mr. Carney noted that the unemployment benchmark should be seen as a “way station” at which the Bank of England would begin to reassess its policy, not a target that would automatically trigger a change in interest rates. The Bank of England selected the unemployment rate as a barometer, he said, because it wanted a figure that was “widely understood and widely available.”

Peter Spencer, an economic adviser at Ernst & Young’s Item Club, an economic forecasting group, said the new strategy would be helpful because Britain’s “economy is in recovery rather than remission, and this guidance gives the bank the flexibility to reduce the risk of relapse.”

Colin Edwards, an economist at the Center for Economics and Business Research, a forecasting firm based in London, questioned what the central bank would do if inflation started to gather speed but unemployment barely moved.

Philip Booth, a director at the Institute of Economic Affairs, a study group, was more outspoken, calling the new strategy “the most dangerous development in U.K. monetary policy since the late 1980s.”

“To use monetary policy to reduce unemployment when inflation is already above target is playing with fire,” Mr. Booth said.

Mr. Carney said the strategy did not mean the Bank of England would abandon its primary objective of holding inflation to around 2 percent. In a letter to Mr. Osborne, the chancellor of the Exchequer, in which he explained the new approach, Mr. Carney wrote that forward guidance “will further enhance the effectiveness of monetary policy so that it fully plays its part in securing a sustainable recovery over the medium term.'’

Giving such guidance “reduces uncertainty because there can be a premature view of withdrawal of stimulus as the recovery builds up,'’ Mr. Carney wrote. Under Mr. King, the Bank of England injected money into the economy by buying £375 billion, or $581 billion, in assets, mainly government bonds.

The “biggest concern,” Mr. Carney wrote, was that some positive economic data would give rise to premature expectations that the bank would withdraw the stimulus.

After closely avoiding a triple-dip recession earlier this year, the British economy has started to show some signs of improvement. Consumer confidence has recovered and the value of homes has risen. Some economists have predicted that growth will gather speed over the rest of the year.

Mr. Carney cautioned, however, that while there was “understandable relief that the U.K. economy has begun growing again,'’ there “should be little satisfaction.'’

“This is the slowest recovery in output on record,” he said.

A version of this article appears in print on , on Page B3 of the New York edition with the headline: Bank of England Links
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